EQ: This week, the market started to sell-off based on perceived hints from Fed Chairman Bernanke that the central bank could begin to ease off the bond-purchasing program later this year. Did the market hear something that it hadn’t heard before to cause this heavy sell-off?
Stovall: Well first, I don’t think the Fed chairman hinted at anything. He basically told us that if the data comes in as anticipated, then they would start their tapering program later this year, and then complete it by the middle of next year. People are trying to figure out what exactly the Chairman said that caused the market to tank so much, and I think it could be because at one point he had singled out an unemployment rate of 6.5 percent as a level at which the Fed would consider hiking short-term rates. And then he later said between 6.5 and 7 percent, implying that maybe a rate hike program could end up occurring sooner than most had expected.
EQ: Does this affect your opinion on the potential severity of the current pullback?
Stovall: I think that Thursday’s closing level is a very important one. We reached an intraday low of 1588.85 or so back on June 6, and if that level holds, we could regard this as very nail-biting re-test of that earlier low. So the S&P 500, as you and I are speaking* is trading a shade above 1600, so if we close at 1585 or higher, then I would tend to say that it is a successful re-test. But I think it’s still within the realm of possibility that we end up closing lower than we did on June 6. I say that because we have had a pullback or a price decline of 5 to 10 percent on average every year since WWII, and it’s basically just a fact of market life that we have some sort of digestion of gains, and actually it would be a very good thing for this to have happened.
Usually you tend to see market declines when investors start to believe there has been a game changing event, because otherwise why would share prices decline in the first place? So I believe that investors are pointing to the Fed’s more hawkish stance as a reason to become more bearish, and that’s why the market is selling off. I think that the Fed is saying the economy is stronger than a lot of people give it credit for.The reason why investors are worried is because they don’t believe that the economy can stand on its own two feet without additional stimulus.
So my feeling is that the Fed is not going to taper if they get data that indicate that the economy is weaker than they think, so somebody’s mindset has to change, and I believe that I would be betting on the Fed.
*[Editor’s note: Time of interview was 2 p.m. ET on Thursday, June 20, 2013.]
EQ: In a few of our more recent interviews, you said you expected the second half of 2013 to be much more volatile than the first. Since late May, it seems like that assumption has already proven true. What did you find by looking at just the closing prices over the past month versus that of the first half of this year?
Stovall: What I saw was a pickup in the number of 1-percent declines on a daily basis for the S&P 500, but what I also noticed was that while we have seen a pick-up, we’re still looking at annualized numbers that are below that of 2012, and about half that of the average since 2008. So maybe it’s because we’ve had so little volatility that the recent pickup in volatility has unnerved investors a lot more than expected.
What I also found going back in time was that actual volatility—that means the actual movement of the overall market, not the Volatility Index (VIX), which is implied volatility—picks up in coincidence or lockstep with a market decline. I really don’t regard volatility as being a leading indicator, nor have I been able to figure out how volatility can help you to decide how deep the overall decline is likely to go.
What I did find is that a lack of volatility is usually a better indicator than the presence of volatility. Similar to trying to forecast a tsunami, I’ve found that the lack of volatility, like an excessively low tide, was a better indication of an approaching storm. So we did reach a very low level of volatility in the first quarter of this year, and as a result that pretty much was an indication to me that we probably would end up seeing more volatility, and the likelihood of a decline of 5 percent or more. However, our belief still is that we’re in a bull market environment, and that because so many investors had hoped that they would get a better buying opportunity, that’s why this decline would not exceed the 10-percent threshold.
EQ: Investors experienced heightened volatility over the past two decades, so this calmer market may be a welcomed change of pace. Is this a reversion to the long-term average or should we expect to return to the major swings of the 2000s and early 2011?
Stovall: I don’t think we’re going to be seeing the major swings that we saw back in 2011. For instance, we had 21 days in which the S&P declined by 2 percent or more. In 2012, we only had three such days. So I would tend to say that maybe we’ll end up with more than three, but we had a near-bear market experience in 2011, thus causing the sharp pick-up in very deep volatility. For 2013, while I think that we could end up seeing a pullback, and maybe even a minor correction as a second event later this year, I don’t really think that we’re going to be seeing a near-bear market decline once again. So while volatility should pick up, it will not be as extreme as we saw in 2011, nor anywhere near as extreme as we saw during the most recent bear market.
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